Few markets are more low-profile, and yet more active and evolving, than the industrial military sector. For the past thirty years, Defence industries have been constantly restructuring their business. Behind this complex trend, lies the increase in the level of requirements, leading some industrial firms to specialize, on the one hand, and others, to elevate themselves as integrators

by Christopher Jones

What Brought These Changes

Such profound and long-lasting shifts could hardly have been caused by a single factor. As often, a conjunction of reasons pushed the military-industrial sector towards this direction, some of them opposing each other. Overall, globalized and liberal economies having acquired global leadership, opened the way for additional creativity and private initiative, which benefit Defence innovation, naturally. On the other hand, many European countries were increasingly regulated in recent decades, with additional public tender rules and mounting government intervention in Defence-related transactions. Perhaps the most potent factor of all, is the simple and natural evolution in the complexity of high-technology, with an ever greater investment effort being put into research and development. These rising investment costs, in turn, have made the military-industrial sector increasingly dependent  on private markets and their available capital.

Also, as industries got more advanced, the armies they equipped became accordingly sophisticated. Vice-versa, the quest for military capacities has acted as a driver for technological improvements. Their stated needs therefore grew steadily, as they strived to stay ahead of potential opponents. Finally, the diversification of missions carried out led them to constantly seek new equipment, needed urgently - something only private firms could provide with their R&D departments. This phenomenon has nicely found its place in budget-control policies, with the private sector now funding research and development, instead of drawing tax money to fund innovation.

Systems Are More Complex Than Ever

Submarines provide a telling example of this trend. The new French Suffren-class submarine has achieved a level of sophistication never before reached in history, when its predecessors, merely 70 years ago, were little more than steel tubes with a diesel engine inside. Observer Chris Roberts writes: “For a generation or more, this has been a two-way contest between the United States and the Russians (inheritors of the Soviet Navy’s traditions and technology), but comes now a competitor. As Sebastien Roblin wrote in The National Interest last week, a new submarine class launched earlier this summer by the French Navy could be among the world’s best.” As the life of operators within submarines became enshrined and politically unacceptable losses, safety came to the top of priorities. Technology became more complex, training got considerably longer and more expensive, to operate these systems.

Technology, as a whole, can be life-saving for a nation, as it can be a pitfall. Underfunded, ill designed or poorly thought-out technology can be the kiss of near death, just as adequate tech can be the key to ending a conflict. The atomic bomb (5), a sometimes supported hypothesis, would paradoxically have saved millions of lives by ending a conflict which would otherwise have dragged on for years. On the opposite, the Petrov case (6) supplied a key example of how technologically can backfire, when a faulty software system nearly triggered nuclear warfare between the US and Russia in 1983. In other, less serious and more common cases, they can simply be a huge waste of money. And when our technology itself kills the soldiers it is supposed to protect, as was the case in South Korea in a K9 self-propelled gun accident, the political fallout (8) is considerable.

Skyrocketing R&D

Augustine’s law dictates that systems will, with time, become more expensive as the number of items drop. The United States’ Navy illustrated this perfectly as its order for new-generation Zumwalt warships dwindled over time, while their unit price kept climbing. Germany has also suffered the effects of this same law, with its operation of Puma Infantry fighting vehicle. Whether these R&D costs are put to good use or not, is yet another conundrum to contemplate, with much debate around the question.

The increase in complexity led to reduction and consolidation in the Defence market: the number of suppliers who could even consider throwing their hats in, for large international tenders, gradually waned.

Finally, the old paradox of fragmentation was still there to complicate the equation further. For instance, the United States have handed considerable R&D budgets (10) to BAE systems to design rail-guns, while France and Germany work on the competing PILUM project (11), with the help of Nexter, Naval Group, ISL, Von Karman and other leading companies. Three long-term allies all funding concurring technology is yet another illustration of the relevance of consortia, but political considerations have often gotten in the way.

The Trend Takes Multiple Forms

First off, State-owned arsenals slowly fell out of grace, for lack of competitiveness. Most have disappeared, and left the business to more capable private industries. And many of these private companies progressively merged together in one way or another, in the attempt to pool their resources, or were simply absorbed by larger companies. As time went by, SMEs disappeared as Konzerns grew larger and went on the prowl for technological “nuggets” to take over.

Evolution of Arsenals

In truth, State arsenals didn’t disappear, but transformed. Generally speaking, in the modern configuration, States keep some level of control, as their sovereignty is at stake. The United States and Germany exercise virtually no control over their Defence industry, but these are exceptions, as the American market is so large that many business can flourish, and Germany has a traditionally ultra-liberal system. However, the term privatization can reflect many different realities: Polish PGZ, Italian Fincantieri, Scandinavian Nammo and Kongsberg, and French Nexter and Naval Groups are all different examples of what privatization (albeit with government involvement) can look like. In smaller countries, where the market is not able to support a private industry, arsenals tend to stay publicly-owned and operated. Bulgaria, for instance, considered privatizing its arsenals and has finally opted to remain as it is.

The Arrival of Giants

Any market share will eventually erode, as technologies get older and lose relevance. In order to address the risk of erosion, many private Defence companies merged, to retain their position. Northrop-Gruman, Airbus and Lockheed-Marietta are just a few examples of these consolidations. In order to fund tech-hungry departments, many firms which operate on the military market also serve the civilian one: funds earned on one side can finance the other, and part of the technology achieved through R&D can be applied to both markets (propulsion, command and control systems, etc.). All in all, only a handful of firms (such as KMW, Nexter, or MBDA) are advanced enough in their respective fields to have remained pure-players of the military segment. 

Additionally, the name of the game is that, the larger the business, the more able it is to intercept public budgets. A recent study over European R&D budgets indicate that over 50% of funds dedicated by the EU for Defence and aeronautics R&D wind up in private pockets. Given the majority of dual players on the market, there is therefore an opportunity for an aeronautics company to get their R&D funded by public coffers, which can they be exploited on the private and civilian side.

The Technological Gap Is Widening

Vertical integration will enable the construction of complex and integrated systems while reducing the number of links in the production chain, in a race to compete with international competition and stay afloat - something Korean Hanwha is fully engaged in, currently. More importantly, the opponents of Western power, mainly Russia and China, are wise enough not to choose the technological battlefield. While their own technology is making some progress, their strategy relies more on attrition and long-term pressure.

Where does that leave us?

In A New Ecosystem

Companies like Nexter, Nammo and RUAG are a new generation: their hybrid structures rely on private capital, partially owned by their national State. MBDA has opted for the State-owned “golden share” system, while Polish PGZ formed an “arsenal holding”. Germany, of all countries, is still running on purely private defence, but has an opportunity, by adopting this new way of doing military business, to “activate” its massive Defence budgets and deeply renovate its capacities. With these new players, inter-government cooperation has become increasingly possible, and the sharing of technological burdens has enabled their nations to stay ahead in the race. Berlin is starting to perceive these new partners as strategic for State interests. For instance, the MBDA-Lockheed consortium initiated a proposal to renovate Patriot missile capacities, based on their own threat analysis. In other words, Berlin will not be able to play its cards close to the chest much longer, lest it completely lose its edge on Defence and security. Secretary of State Benedikt Zimmer explains how French and German cooperation is crucial to maintain strategic know-how, as reported (12) by Reuters Andrea Shalal: “Arms makers need to move beyond mere cooperation agreements and deepen ties, Benedikt Zimmer told hundreds of industry executives and military and government officials at the Berlin Security Conference, and said the drive was supported by the top levels of the German government.

“You can call me a dreamer, but if we don’t get it done, we are on the best way to making Europe obsolete,” Zimmer said.” Consolidation is called for by many of the sectors representatives, such as BDI President Dieter Kempf. However, as a Union representative, Dieter Kempf doesn’t wield the political power to make this happen. This role would befall State secretaries Benedikt Zimmer and Ulrich Nussbaum, in so far as they able to understand what is at stake, which they obviously do. Historically, German officials have always been very timid at the idea of intervening within private Defence matters, which enables RheinMetall to try to derail the aforementioned consolidation, against national effectiveness and performance, and form a new German-German partnership with KMW. 

The beneficial effects of a “Defence ecosystem”, such as the French one, cannot be hoped for in Germany, in the current state of affairs, despite political momentum to do so. But Germany can, however, inch closer to France. German Foreign Policy (13) writes: “German government advisors are praising the French government's new military policy document ("Revue stratégique") and are calling for accelerating the expansion of German-French military and arms cooperation. With this document, Paris is opening itself up "to cooperation in Europe, to a degree previously unknown," according to the German Council on Foreign Relations (DGAP), thus offering the possibility for rapid progress in the formation of European armed forces.” The fine balance between State interventionism and ultra-liberalism has shown itself to be the key to economic performance and operational relevance, in France, the United States and Scandinavia. If the German State leaves all control to the private sector, State Secretary Zimmer can expect Defence invoices to get out of control, in a hurry.

The Hegemony of Systems Integrators

The old days, in which only the platform mattered, as long as all other systems could be duct-taped to it, are gone. The “system”, as a whole, is now at the heart of all considerations. The United States are still able to use efficiently 40-year-old U2s and 60-year-old B-52s(14), precisely because they are used within the frame of a high-performance combat system. This gives systems integrators a key position. These systems rely on integrators (the big ones, such as GDLS, BAE systems, Dassault… or the smaller ones such as Damen, KNDS, etc.) who act as architects and ensure the overall coherence and management of the entire program. They are supported by subcontractors (such as Thalès, Harris or Rode & Schwartz…) who can also, sometimes, integrate parts of the system. 

The “Capacity” Approach

As detailed by the latest Rand Corporation report, systems integrators are not suppliers. They are responsible not for the delivery of an item, but for providing the client’s capacity to perform various strategic missions. Moving from a market where piling up tanks and lining up soldiers, to a world where capacities were at the centre of the mind frame, changed everything and placed systems integrators at the helm of the Defence industry. The simple addition of means simply no longer will do.

Supplier Specialization

With the massive reorganization of the market, a new infrastructure has now been designed and collectively accepted, and is clearly illustrated in EU literature. Prime contractors (the system’s integrators, such as BAE, Dassault, Nexter or Saab) are the industrial counterparts of nations: they provide the means to enforce sovereignty and the capacity for Defence. They are supported by three tiers of subcontractors, which supply, on the primer contractor’s demand, whichever parts or subsystems are needed. Tier-1 subcontractors are essential for weapons systems, but quite often interchangeable, which is not the case of systems integrators - think Thales, MTU, Rohde Schwarz, etc. Tier-2 and tier-3 suppliers provide non-essential and non-critical services.

Christopher Jones is an international defence correspondent. Views expressed are of the author and do not necessarily reflect the views of IDN